Hedging fuel? Never say never! (1)

In the current flood of exchanges about the imminent increase in local fuel prices one notes the occasional reminder that Enemalta has, for some years, refrained from hedging its oil purchases as a matter of policy.

Apparently, this policy was based on the view that hedging was considered no better than speculating with the people's money. This, if true, would be a truly remarkable inversion of logic.

The case for hedging should start from the premise that Enemalta recognises the need to crystallise in advance the cost of at least part, if not all, of our fuel imports, because neither Enemalta nor the country can afford to be left totally open to the vagaries of future movements in the price of oil.

To adopt a policy of 'absolutely' no hedging is arguably much more speculative than taking steps to mitigate the risk of volatile oil markets, and that has to involve a hedging strategy. This may mean that you do not always hedge all future estimated demand, or that you hedge in different ways and at different times.

The case for hedging now or in future is also being questioned because recently the relevant fuel forward prices have been higher than the spot price. But this in itself is not a good argument.

As for other commodities, holding physical oil in storage yields no income, but does involve storage costs and finance costs. You therefore have to expect that normally the forward price should be higher than the spot price. If a particular commodity is in addition seen to be in short supply, there will probably be an additional premium to pay as well in the forward price.

Naturally, this does not necessarily mean that the best way to hedge is to buy forward, rather than buy spot.

Our present predicament may owe much to poorly interpreting the lesson of some years ago, when Enemalta may have over-hedged in a trend of falling prices.

In my view, it is unwise for Enemalta to totally ignore hedging as a means of managing the risk of volatile fuel prices, especially within an over-arching strategy that addresses the long-term vulnerability our economy to higher fossil-fuel energy costs.

Perhaps one way forward (if you excuse the pun) is to give fuel and electricity consumers the facility of buying some form of future consumption units from Enemalta at current prices adjusted higher by a margin to reflect reasonable carrying costs. That way, the risk management of energy costs will be shared better by the people.